ECB president Mario Draghi (Photo: Action Press / Rex Features)
Mario Draghi has played a weak hand with skill, as always. He is a superb actor.
Yet the package of measures unveiled by the ECB yesterday is pitifully small and mostly window dressing, an effort to buy time with a mix of vague gestures and outright gimmicks, a substitute for decisive action.
“This is a classic ECB play of the kind we have seen so many times over the last three years,” said Andrew Roberts, credit chief at RBS. “There is huge smoke and mirrors at the time of the announcement, but when you go through the figures 24 hours later you realise it is nothing like what you thought.”
The delirious reaction of market traders is interesting, but essentially just noise. What the ECB did will not move the macroeconomic dial by one iota.
As Christian Schulz from Berenberg Bank puts it, the latest rate cuts are a screen to “paper over divisions”. The ECB could not secure German political consent for genuine reflation, so it put on a pantomime instead.
The new measures add little to what was already on the table in June. Some are marginally helpful, some trivial, with a shocking lack of detail about the one point that really matters.
The ECB has had years to plan asset purchases (QE Lite), yet Mr Draghi dodged all questions about the scale. You might conclude that there is still no real agreement on the course of action. Little wonder since Germany’s member of the ECB board – Sabine Lautenschlaeger – said only two months ago that QE is unthinkable except in an “emergency”, and no such emergency exists.
By default, the ECB is making the same mistake as the Bank of Japan in its dog days, trying to buy time with half measures, hoping that global recovery will lift Europe off the reefs without anything being done. They may get away with this, but there is a very high risk that Europe will instead remain trapped in mass unemployment, with ever rising debt ratios.
The overall policy settings remain contractionary. Monetary policy is still too tight. Fiscal policy is too tight. Bank regulations are too tight. Little is in fact being done to stop a deflationary psychology taking hold across half of Europe. Nobel laureate Joe Stiglitz warns of a depression running through most of this decade.
Mr Draghi said he hopes to “significantly stir” the ECB’s balance sheet back towards the levels of 2012 (€3.1 trillion). That means a €1 trillion boost, and there begins the first big confusion. Much of this will be in the form of cheap loans to banks (TLTROs) in exchange for collateral.
As the IMF said earlier this summer, this not remotely akin to QE. The ECB is not taking the risk on its own balance sheet. The monetary mechanism is entirely different, and far less powerful.
The original €1 trillion of LTROs in early 2012 were a lifesaver because EMU was then in a financial crisis. It stabilised the system (for a few months). But euroland is now facing a different problem. It is in a chronic deflationary malaise, a bad equilibrium. Households are paying down debt. Demand for credit is muted.
Mr Draghi himself suggested in July that the forthcoming TLTRO auctions could reach €1 trillion in various forms. (From which you then have to subtract repayments from the old LTROs). Nick Matthews from Nomura calculates that the actual purchases of asset-backed securities, mortgage bonds, and covered is likely be near €450bn, though others suggest it may be even lower.
This would be spread over three years, a mere €12.5bn a month. This is derisory, and will not even start until the end of the year. All the evidence is that QE works through a critical mass effect. It must be carried out swiftly and with maximum force to break out of the vicious circle.
Marcel Fratzscher from Germany’s DIW Institute has called for €60bn of sovereign bond purchases each month, equal to 0.7pc of total EMU sovereign debt, and roughly in line with moves by the US Federal Reserve.
The Bank of Japan is buying some €55bn worth of assets each month to defeat deflation. This is equal to €140bn of monthly purchases in the eurozone on a GDP ratio basis, ten times more powerful than anything the ECB is talking about.
Nor is it clear how much the ECB can really do since Mr Draghi made a throw away comment that it would buy only “high quality” assets. “It’s absolutely pointless. There is no point bothering if they are not going to take any of the bad stuff off bank’s balance sheets,” said Mr Roberts from RBS.
As for the ten basis point cut in the main interest rate to 0.05pc, it will make no difference, beyond ensuring that banks turn up to bid at the first TLTRO auction later this month rather than waiting until December. Michael Kemmer from the German BDB banking federation says the impact will be “negligible”.
Georg Fahrenschon from German’s savings bank association called it “interest rate cosmetics”, warning that the “latest mini-steps will achieve nothing”. They merely underscore that the ECB has shot its bolt.
Liane Buchholz from Germany’s association of public banks compared it to “a late summer sale”, doubting that it would do anything to entice eurozone banks to take on more risk. How could it do so since new rules and higher capital adequacy ratios are still forcing lenders to deleverage, in some cases with manic determination?
The cut in the discount rate to minus 0.2pc is clearly intended to drive down the euro, so far successfully. It is however a hazardous strategy, which is why the US Federal Reserve and the Bank of England never went this far. Much of Europe’s €900bn money market industry is sliding under water. We can expect an exodus over the next two months as maturities expire.
The ECB is twisting itself in knots, undertaking ever more complicated operations because it will not bite the bullet and launch plain vanilla QE, a €1 trillion blitz of sovereign bond purchases, starting immediately, and with no ifs and buts.
It is not doing this because Germany has a de facto veto, and everybody knows that there will be a challenge filed at the German constitution court the moment any such action is taken. This is not a criticism of Germany. I entirely agree with German patriots who say that QE is fiscal union by the backdoor and an assault on the budgetary prerogatives of the Bundestag, an evisceration of German democracy. It is a criticism of the irredeemably hopeless construction of monetary union. My argument has always been that EMU should be dismantled because it is a creeping danger to democracy.
If the brilliant Mr Draghi were running a real central bank, he would simply carry out old-fashion open-market operations – with an eight hundred year history – and keep buying assets on whatever scale is needed to meet the ECB’s 2pc inflation target. Instead he running a zoo. He is forced by abominable circumstances to blow smoke in our eyes. He is good at it though.
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